Chapter 2: The Balance Sheet 

Objective 2.1: Identify financial effects of common business activities that affect the balance sheet.

Making a Balance Sheet

• The three sections of the balance sheet consist of what is in the basic accounting equation:
  • Assets
  • Liabilities
  • Stockholders’ Equity
• As a reminder: Assets = Liabilities + Stockholders’ Equity

Financing and Investing Activities

• When starting a company, a key factor is financing, which has two types:
  • Debt financing - the money and loans that a business borrows from banks and will repay in the future. A business must repay its debt financing.
  • Equity financing - raising money by selling shares to your stockholders or investors. Equity financing is not obligated for a business to repay.
• After financing, the next step in for the business to start investing in assets like supplies, equipments, logos, office space, etc.
• There are three features in accounting:

  1.) Companies documents all activities (loans, purchases, sales)

  2.) There is $ALWAYS a give and a get in exchanges/transactions$

  3.) Following the cost principle, a designated dollar amount is chosen (ex: The American dollar)

Transactions and Other Activities

• Companies have external exchanges and internal events
  • External exchanges happen between a company and someone. For example, this can be a company selling a product to a customer.
  • Internal events involve, within a company, privately utilizing assets to create another asset such as selling a product to get cash.

Objective 2.2: Apply transaction analysis to accounting transactions.

The Accounting Cycle

• The accounting cycle is used to report the financial information of a company.
• Accounting cycles occur day after day, month after month, and year after year.
• Each transaction, which is a business activity that has an affect on the basic accounting equation, is recorded.
• $The accounting cycle occurs in the following order$:
  • Analyze
  • Record
  • Summarize
  • Prepare a Trial Balance
  • Report Financial Statements
• After these steps, the cycle starts from the beginning again.
• During the analyzing stage, two ideas must be considered:
  • Each transaction involves a duality of effects, meaning it has two effects on the basic accounting equation.
  • Assets must ALWAYS equal Liabilities + Stockholders’ Equity

Step 1: Analyze Transactions

• Account titles are given to items that are exchanged, whether they are assets, liabilities, or stockholders’ equity.
• A chart of accounts contains many of the common account titles. Some examples include:

Example Transaction Report:

• A company buys supplies on account for $1,000 (asset increases, liability increases):

• Later, the company will repay the Accounts Payable of $1,000 (liability decreases, asset decreases):

• $Exchanges that consists of only promises are not considered to be transactions$, therefore they do not need to be reported because they have no effect on the basic accounting equation.

Step 2 and 3: Record and Summarize

• Transactions can be recorded using a spreadsheet.
• Journal entries are created to record financial effects.
• After creating a collect of journal entries, this information is then summarized into ledger accounts (T-accounts)
  • A T-account has a spot to put the account name, a spot for debits, a spot for credits, and a spot to put the account’s ending balance
  • $Debits (dr) are on the left and credit (cr) are on the right.$
  • An example of T-accounts using the last two examples

Objective 2.3: Use journal entries and ledger accounts (T-accounts) to show how transactions affect the balance sheet.

The Debit and Credit Framework

• $Assets, liabilities, and stockholders’ equity all have a normal balance$, being either a debit or a credit. Their normal balance is the side that makes the account increase.
  • Assets have a normal DEBIT balance
  • Liabilities have a normal CREDIT balance
  • Stockholders’ Equity has a normal CREDIT balance
• TIP: An account’s normal balance is on the side it appears in the basic accounting equation
• A (left) = L (right) + S/H (right)

• The debit/credit framework is used when making journal entries, which shows how transactions effect accounts.
• A journal entry can contain several different accounts and are listed by date in which the transaction occurred.
• $A journal entry includes$:
  • The date of a transaction
  • The account name
  • Debits
  • Credits

Objective 2.4: Prepare a trial balance and a classified balance sheet.

Step 4: Preparing the Trial Balance

• A trial balance totals up the debits and credits of each account, but $it is considered a draft$ and not a final.
• A trial balance example would be:

• Total of Debits = $34,100
• Total of Credits = $34,100
• Debits = Credits ($34,100 = $34,100)

Step 5: Preparing a Classified Balance Sheet

• The classified balance sheet is the final after creating the draft and has a different format from the trial balance:
  • Assets
  • Current Assets
    • Total Current Assets
  • Other Assets
  • Total Assets
  • Liabilities and Stockholders’ Equity
  • Current Liabilities
  • Total current liabilities
  • Other liabilities
  • Total liabilities
  • Stockholders’ Equity
  • Total Stockholder’s Equity
  • Total Liabilities and Stockholders’ Equity

• $Current vs Non-current$
  • Current Assets: Aka short term assets, will be used or sold within the year.
  • Non-current Assets: Aka long term assets, will not be used or sold within the year.
  • Current Liabilities: Aka short term liabilities, will be due and repaid within one year.
  • Non-current Liabilities: Aka long term liabilities, will be paid after a year or more.

Objective 2.5: Interpret the balance sheet using the current ratio and an understanding of related concepts.

The Current Ratio

• The current ratio provides information on a company’s ability to pay.
• You want to have more assets than liabilities.
• ==Equation to calculate current ratio:==

• Current ratio example (using classified balance sheet from above)
  • Total current assets were $20,800.
  • Total current liabilities were $10,000.
  • 20,800 ➗ 10,000 = 2.08
  • The current ratio = 2.08

Balance Sheet Concepts and Values

• The process of recording and reporting transactions has an effect on:
  • What is and is not recorded on the balance:
  • Assets like cash, equipment, and supplies can be effected.
  • Although ethics, creativity, and vision are not listed, they can still be effected.
  • The cost amounts assigned to the recorded items:
  • When first recorded, assets and liabilities are recorded at initial cost, following the cost principle.
  • If the value of an asset decreases, we adjust the value recorded.